Is Shanda Games Recession Proof?

Traders who took advantage of our January 21 article on Shanda Interactive Entertainment (SNDA) have enjoyed quite a ride! The stock is currently up roughly 100% in less than six months, handily beating market returns. The sector has been a bright area to invest in, as China Massively Multiplayer Online Role Playing Games (MMORPGs) gain popularity. For many consumers in China, Shanda games have been a less expensive form of entertainment, so the industry has enjoyed dollars (or more appropriately yuan) that might have otherwise been spent on travel, expensive dinners, or new vehicles. It’s easy to see why some investors claim that china online game companies are recession proof.

But despite the solid earnings at Shanda, and the recent sharp move in the share price, SNDA stock still appears to be undervalued with significant room to run. Analysts who follow the company expect earnings to hit $3.39 per share this year representing an increase of 29%, and for 2010, earnings are expected to hit nearly $4.00 per share - another 17% on top of 2009. The stock is trading in the mid 50’s, setting the PE at 16 compared to 2009 expectations, and just 13.75 compared to 2010 expectations. Considering the proven track record, and strong financial footing, I find it difficult to understand why this stock doesn’t have a multiple of at least 20 times next year’s EPS.

At the end of the first quarter, Shanda was sitting on $477 million in cash as well as an additional $207 million in short-term and marketable securities. That’s quite a war chest for a company that pulled in $569.5 million in revenue over the past four quarters. A certain amount of cash on hand is important as the company pays to develop new games or even acquire properties from competitors. But considering the fact that Shanda has no debt to speak of, this cash balance should give investors a strong sense of security as there are very few scenarios which would come close to putting SNDA in a difficult place financially.

One initiative that might help stoke investor enthusiasm is a potential IPO of Shanda Games on the US stock exchanges. According to the company’s press release, Shanda plans to submit registration documents to the SEC for a possible Initial Public Offering of Shanda Games Limited. The potential spinoff of the online game portion of the company’s business could help isolate the strong growth area of business from other entertainment business lines run by the company. At times, this type of strategy increases shareholder value as the new more dynamic portion of the company can trade higher without the baggage of a slower growing business line. It appears that Shanda Interactive would still maintain a majority position in Shanda Games Limited.

Shanda has also been active on the acquisition front, most recently putting cash to work purchasing Hurray Holding Company (HRAY) which is a music distribution company. Shanda paid roughly $46.2 million for the purchase and should be able to use its wide distribution and client network to make this a profitable acquisition. It’s encouraging to see the company putting capital to work and taking advantage of its strong financial presence.

The company gave no guidance for the second quarter which has likely had a negative impact on the stock price. Investors hate uncertainty, so when there is little guidance from management often buyers will step back for a quarter or two in order to make sure the positive trends are still intact. When the company announces second quarter earnings it is likely that uncertainty will be put to rest and the stock could ramp higher from that point. I would recommend holding SNDA through the $80 level and possibly further if the earnings expectations are increased. The stock is dynamic and volatile, but a long-term perspective could put some nice profits in your portfolio.

Disclosure: Author has a long position in the ZachStocks Growth Model

Comments

[User 439661:]

Contrary to the statements of the author, SNDA did provide 2Q guidance. In their conference call, SNDA stated that for 2Q they expected revenues to increase 8-10% quarter over quarter and operating margins to remain similar to 1Q. Providing a revenue estimate and a trajectory for operating margins (up down or flat) is all that SNDA has ever provided.

Jul 02 09:29 AM

[Jessie09:]

If SNDA is recession proof, we will need more of this! Everyone is affected with this crisis. They hate RMT so much but read this article, I admire how the student managed to go on. -- www.linkgeneral.com/ar...

Jul 02 08:51 PM